The 5 Year Plan

There are certain things in life that you know are mistakes because you have committed them. If you had not made those mistakes, you would have lived in doubt. If you commit twice, you are on your own.

If the caption of this blog grabbed your attention, there is a fair chance that you would have lost money in the financial markets. Take that as an allowance as the anticipation of making money is far more rewarding for that's how the brain is wired. Marketers use ‘buy one get one free' schemes to attract more customers than ‘a 50% discount' although both are same. Most popular investment avenues that attract maximum investments are created on similar lines and must be deplored. The best ones are those that do not look all that attractive, are time tested, bought but not sold and rooted in principle of compounding over long time than ‘Big Quick returns’.

Investing is part art and part science and hence the difficulty in laying down several steps to be a successful investor. It’s easier to say what can be detrimental to good investing. Meet Amrit Pal, who claims to have compounded an average yearly return of 21%+ over the past decade. Now that means an amount of Rs. 10,000 invested every month for last 10 years would be Rs. 40 Lakhs.  Ask him what his secret is and he goes 'value investing'. His approach is to buy businesses that are trading at less than its intrinsic value calculated using discounted cash flow formula. There are many websites that provide this value for many listed companies. During times distress, Amrit identifies such business which is available at least at 30% discount to its intrinsic value. Temporary setbacks lead to a crash in stock prices of even valuable companies with a durable moat. In simple terms, this is buying 100 rupee worth asset at Rs 70 or lesser. The greater is the uncertainty or setback, the bigger is the discount these companies are available at. And bigger would be the returns. Gruh finance at 190, LIC at 180 after the bribe scandal broke out was such value picks. Even our pick, Cera went through a crash when one of the promoters died pulling the stock down to 280 less than a year ago; two weeks ago it was trading at Rs. 500. The market realizes the anomaly and at some point corrects it to near intrinsic value, offering great returns. Great business gems offer such buying opportunities few times in its business cycles and it is for us to lap them up. And at those times, as Spider our proxy investor puts it - 'back up the truck and load it'.  Recently we did identify one gem which is available at 38% discount to its intrinsic value and it is one of the best managed companies in our country. It’s a matter of time before the market realizes this anomaly and offers it its due price. Here we are making an assumption that those are the businesses that pass through several of our filters and we would really want to be investing in them.

Such opportunities come far and few, and when they arrive lets recognize and take big bets. Like Amrit, it pays to keep a minimum of Rs 5 Lakh in banks as reserves for initiating purchases in special market situations. That’s when the stocks are on sale and on huge discounts, 1+1 offer so to state.

Khabari network

There is an internal network that runs the market, everything is fixed and rigged. There is plan and only known to a select few. They make the markets move as per their wishes. Its Operators who make and run the markets. This is what everyone who loses money in the market believes before he surrenders. Then there are a few who look for this Khabari network and believe if they get to the inside of this network, they can make immense wealth in no time. 

Very recently, an investing fried shared is experience. He received a sms from another contact who seemingly was ‘in the inside’ of a very secretive and powerful network. His sms read, “MMTC: EGOM to fix price at Rs. 230 per share. Meeting at 2.00 PM sure shot. Stock heading towards lower circuit.. Short MMTC.”  In simple English, the news was supposedly giving away something very confidential, that the government was planning to sell part of its shares stake at 230 lower than what was it was trading at that hour,Rs 283. My friend went for the phone and placed ‘a sell’ order for a few thousand shares at Rs 283 hoping that it would slide down and he can buy at lower prices. What had happened is that almost every investor had got this information and shorted the stock ( in market parlance, it means to sell MMTC without having the stock and hoping to buy at lower levels, same day). In a few hours another Khabar made its wave that sent shivers down all the short traders. The MMTC’s banker had rejected the offer on lower valuation concerns and in moments the stock started spiraling upwards leaving all our khabari investors in a spot, as it meant they had to buy them at higher prices to square their position. My friend bought all the shares back at Rs 310, loosing effectively about 10% in a few hours and few lakhs of money. Most investors who listened to the Khabar had lost upto 15% that day.

And now the secret. All known information (and sometimes unknown) is reflected in the stock prices. There is no one capable of rigging the market. Even the entire might of UK could not be put behind to save the British pound from the crash, an event when George Soros made his billion by shorting the British pound. Where then can individuals or a group of them hold reign of influence beyond fractions of a second. However as a fund manager puts it, it is the smart money that moves the markets. Think of smart money as the largest groups of investors like fii, pension funds and other institutions that invest billions of dollars. In the short run their emotions and outlook make the markets while in the long run their beliefs would align to the fundamentals of the stock. One of the challenges faced by retail investor is that there are large number of variables that make understanding the fundamental  of a company very difficult. Remember when every learned fund manager expected Educomp to be the next infosys and a multibagger stock. Most of them got it wrong on the issue. Satyam was yet another case where till the very end no one could predict it was led by a fraud management. I guess corporate themselves are not sure of the quality of their own management, how can then an analyst and worst off all, retail investors like us, ever get a grasp of fundamentals. There are infinite variables while evaluating a company and one can never get it right. 

I remember the dialogues in the movie 21, an MIT Blackjack Crack team. As the professor says, there are those with gifted minds, if they had been able to get beyond some of their personal mistakes that were made and yet as history shows us, some students never learn. This is the state of most of us. And not everyone can do it.

You lose only out of paranoia, fear, emotions. You don't give in to your emotions. You think logically. As the Nonlinear Equations professor in the movie said”Always account for variable change".

The investing success is based on secrets that are very simple, hence does not capture people’s imagination – invest regularly, over long periods of time, preferably in the whole market index – and let power of compounding take charge.

Risk of holding vs. selling

Digest this! The risk in holding a stock that can virtually go down to zero is lesser than the risk of selling a winner too early. I realized this when Rakesh ran a few numbers to me. He had invested in Suzlon and Ultratech cements in the December 2008. Suzlon ran down from its 2008 highs of 62 to 25 now and Rakesh lost 60% of his investment. He had also bought Ultratech cements at 366 at the same time but sold it 2 months later after it appreciated by 20% to Rs. 439. He displayed a very normal behavior of holding on to the loosing stock but selling a winner. He holds the suzlon stock even now which is quoting at around 25 unable to accept the loss. He is hoping it will regain its original purchase price and he could avert a loss.

The biggest folly that leads to investing failure is not about holding on to a looser, but the selling off a winner. On one hand Rakesh held on to Suzlon hoping some day he will be able to pare the loss, on the other hand he sold Ultratech cement after it appreciated a meager 20%. Imagine a different scenario: Rakesh had held on to both the stocks until now, and that he had invested a similar amount of Rs. 1 lakh in each of them, his Rs. 2 lakhs investment would have now have become Rs. Rs 5.60 lakhs.  (1 lakh invested in suzlon would now be Rs 40,000 while Rs 1 lakh invested in Ultratech would have become Rs 5.4 Lakhs). This is a return of (cagr) 26% pa over 4 years. This is better than inflation. Imagine you virtually held on to a looser that has dented your pride, yet your action of holding on to a gainer would have more than compensated for the losses.

Rakesh was influenced by analyst’s definition of cyclical stocks and sold the cement stock expecting a glut in the industry to hamper growth prospects of Ultratech. And he reasoned the he could buy it cheaper later. The market is filled with very knowledgeable people who can define every situation and put a reason and logic to everything they have to say. The best time to sell a stock is 'never' as long as the company shows predictable earnings growth over long term.

Short term fluctuation must be ignored as long as the company is run by trusted management and the business has long term growth prospects. The risk of selling a winner far outweighs the risk of holding on to a looser. Hence it is wiser to hold and be proven wrong. A stock can only get to zero on the downside but technically there is no limit to how high it can go. Do not get swayed by stereotype definition of when to buy, when to sell. Experts can christen their style and call them such as earning or growth generator, contra strategy, special situations, mutlibagger ideas etc. These are traps for a small investor. Invest for the long term in companies managed by trusted people, who have displayed legendary commitments, where the industry has long term prospects and businesses have an irreplaceable value, provided you buy them cheap. Rakesh should have continued to hold his Ultratech cements, business that are subject to low rate of change. Cement is a mundane product that everyone needs subject to slow rate of change, as the legendary investor said, change is the enemy of investor.

 People will always buy cooker, under garments, financial services, cement, loans unless something terribly goes wrong. There is always the risk of unknown; we could face a period of prolonged recession. Risks are real, depressions are friends of investors. If you get a chance, buy distressed businesses in a distressed industry. Eventually markets will catch up with the true value of the business.

New Hope

What does a new year hold for us investors? Nothing much. The market really does not change anything that day nor do the businesses that they represent. It is still a good time to recommit on the way we will invest rather than on what we will invest. It is incidental that it was a great investing year when my portfolio returned 57% and the index itself returned about 25%. Hindsight as they say is the best sight. Not to get carried away, let’s remember how investments are behaving matters less than how we behave. And hence in this New Year blog I would like to remind ourselves on some of the healthy and profitable investing habits.

Never invest at once all the money earmarked for equity. Invest over a period of time.

Never allocate a large portion of cash into a single stock, be diversified (say 10 stocks).

Evaluate the performance of businesses, whose stocks are owned, once in 3 or 4 months

Moderate expectation of returns, do not expect more than 12 to 14% pa and make plans accordingly

Do not invest the money in stocks that you will need back in 3 years - must give time for equity to perform.

Never invest based on tips or rumors- you will win some and loose many- its a zero sum game

If you can't commit time and resources, just invest in a mutual find or an exchange traded fund of the index

I can assure you that you have reasonable chance at investing success.

The booster dose comes from many themes we have discussed earlier; today I am studying the banking and finance space. The opportunity lies with many psu banks that are undervalued due to higher provisions, bad loans and non performing assets. However reasonable valuations and profitability make up for the low asset quality. Make sure to avoid stocks that are popular with analysts as in the long run they tend to under-perform the un-analyzed ones. Analysts avoid stocks with uncertainty that make them undervalued buys today that will go on to outperform in the long run. Remember the  Cera Example

The successful investors put a process in place and stick to them, never investing on news or impulse.

Wishing you the very best in the New Year.

Surrogate Investing

On May 6th last year, I had recommended in a previous blog  of a small Sanitaryware company, Cera Sanitaryware, that i was investing in. It was available at Rs. 192. Some readers wrote to me and I shared the rationale behind this investment. The decision happened a few week earlier when I went hunting with a friend for a plot of land that he wanted to buy. I was witnessing the rapid pace of urbanization in the suburbs where there were large number of houses and flats being built. In general one could see massive build out across the country such as residential and commercial complex, malls, entertainment plazas, self-contained cities, airports. The most obvious idea would be to buy land or flat, but I was reminded that in the gold rush, people who made money are the ones who sold  shovels & pick axe, and not the gold pursuers themselves.

My friend who was excited with the commercial activity started discussing ideas such as opening a hardware shop to cater to the demand of construction. The operational and statutory challenges in managing an enterprise, the vagaries of limited economies and the tied down approach to running a specific business that won't allow for hedging across a larger market opportunity made me think differently. Why not look for existing enterprises who have far greater skills and experience in managing all of these. My search led to the very small but fast growing Cera Sanitaryware. I preferred this over its larger peers due to better ROE and to take advantage of favourable valuation that offered a decent margin of safety. It was not covered my many analyst and was a great candidate for what we call value unlocking. When you feel from the heart, you rarely go wrong. The investment has doubled in 18 months.

The purpose of this blog is different. When some asks what stocks I hold, the typical reply is, it is not important what stocks I hold, but what rate I bought them. The search for the next multibagger is always on.  I was reminded on a recent flight when I read that the closest exit row might be behind you. The next big investment idea is sometimes behind us, already the one we possess. With my recent analysis of Cera, I am once again convinced that it’s worth more investment if one is looking around 20% for next few years. If you are interested in knowing the rationale and risks of this investment, you could write to my researcher and friend ram@learninvest.in. I rarely recommend stocks on this blog as the original intention is to share learning from successful investors. I prefer to focus on the process than the outcome. This learning of 'a surrogate play' through my research on  Cera was entrenching and the only focus of my blog. Do not blame me for your investing success or otherwise :) 

One of the biggest challenges to the Indian equity market is the reliability of the promoters. You can have a very attractive balance sheet or financials dressed from a black sheep promoter and he would be superstitiously siphoning away the money. I know of people who do not want to invest in Indian equity markets as they are it is not well regulated. There are scores of company promoters who have made it big and got away at the cost of retail investors. You may remember how 'the darling of the market' only a few years ago, Subex systems (with then revenues about USD 50 Mil) went on to buy a company making revenue of $12 Mil, paying a whopping $170Mil. To every one's wonder, it was an all cash deal and the stocks lost from Rs 800 to sub Rs 20 levels. I have serious doubts about underhand dealings and the promoter is today freely driving in a Prado. Incidentally the company Subex systems, develops fraud management systems, just that we did not comprehend that fully.

other ideas you may like
Trap Door.
and Desire deserve dream destine .

Invisible Hand

Recently I was introduced to a real estate investment opportunity in Bangalore outskirts along with a few other friends. The views after seeing the property were very diverse from excitement to resistance to predictions of the future. It was interesting to see that, to what some of them considered a great opportunity there were an equal number who were negative about it. The ones who took a negative view said that the development had not started on the project and that it would take many years for the area to boom. Now as investor would you not look at those as reasons for a favorable valuation? Investments are made at times of extreme uncertainty and when full potential is not realized. The favorable ones said, you do not wait and invest, you invest and wait. A very successful real-estate investor remarked, with investments in real-estate, just ensures you have choices when buying and have plenty of time & patience while selling and success is assured.

This month’s investor meeting was with an equity researcher whose name I withhold. He had devised a PE ratio based contrarian program that can be used by any retail investor. It does not require a lot of time, yet very effective in the way it is designed. He has validated his research over the last 10 years data. To make the choice of stocks sound, he suggests the retail investor to look at the 100 companies from CNX-100 index. This way we ensure a level of filtering for the small investor who lacks the domain knowledge. To reduce time& amp; effort involved, he recommends transacting and examining portfolio only once a year. The investor in this program buys a list of 10 stocks that have the lowest PE from the sample of 100 CNX-100 stocks on a particular day. He then blindly holds it for a period of one year and a day. The portfolio is liquidated after one year and a new portfolio is formed with 10 new low P/E stocks, some of them might be old ones.

You are also taking out the profit at the end of every year and leave only the initial investment in it. This way you can make it an asset that is generating income, excepting when the return in a year is negative (during the research period 2000 to 2011, there were 2 such years were returns were negative). By holding it for a period of 1 year, you are not subjecting the income generated to taxation.

The results show that of the 11 years, 9 years portfolio offered superior return. The average yearly return is 51%, which is pretty impressive. We could use different variations of this program by changing the holding period to 3 or 6 months or using cnx500 companies instead of 100 etc. For a copy of the research data, please write to me on naresh@learninvest.in

The pace of change intensifies in this competitive rat eat rat environment. The lobby power still remains supreme in businesses with large capex requirements. Corruption and greed make it difficult for the just-wise to make a living as crony capitalism and muscle strength reign over knowledge and logic. The revolution for collective awareness is underway. How then do honest companies and individuals continue to grow? The power of invisible hand says if individuals pursued only their interests, they would promote the public welfare which was not part of their intentions; they were led by an invisible hand.

Other ideas you may like

 

Trap Door.

Desire deserve dream destine .

 

The Trapdoor Delight

I did not quite comprehend with Warren’s beliefs of a ‘lifetime holding’ during my early investing career. It was later when I understood that lifetime holding of a stock did not mean ‘buy it, shut it and forget it’. It is because Business landscape changes so frequently that it can devour a very successful company in no time. 75% of the fortune 500 companies that existed 20 years ago have disappeared. The very thing we are sure is that future is going to be very different. A Kodak moment can happen to any business.  Lifetime holding means no less work in analyzing a stock. It requires a persistently examining eye to know that HDFC bank with 9 branches would grow to have more than 3000 branches in 16 years, that they have being incessantly growing quater o quater by 25% for past several years. And With that knowledge, holding on to it during such period, is a lifetime investment.

On the other hand there are investors who specialize in situational opportunities; they use the very rapidly changing and uncertain business economics to their advantage. They work on special situations. They enter the trapdoors that others frown upon. I met one such investor,   Rahul Paliwal who invests only in exceptional condition, trap doors. He waits patiently for policy to be passed, ban lifted, patents infringed, war waged or fraud revealed.  This person has been holding on to Hawkins for a long period of time although it has not performed brilliantly in this period. He is working on the knowledge that there is unmet demand for their cookers that was not served due to deteriorated labour relations and an order of Pollution Control Board to cease operations as they were allegedly producing polluting effluents. Rahul knows that it is a matter of time before they work the approvals through. He admits that this is a hard job, requiring him to be on top of things, but the returns have an honest upsides and situational investing is all he does. The FDI in retail is a case in point and I had highlighted this in a previous blog although one never knows when it will really materialize. Kingfisher or the UB Spirits were also trapdoors of special situation and so were Satyam computer, when the scam was revealed.

To put an element of investing perspective in it, I may say that there are opportunities that exist based on arbitrage of either time or information. Investing Opportunities that exist for a brief period of time or based on specialized knowledge, dilute in their essence with time or upon event happening.

This method of investing must not be confused with speculation based on tips. Hence it requires knowledge of fundamental analysis and that of business- economics. Rahul is currently investing in another special situation stock that he expects to give him a mutibagger returns.

I would not recommend this to the uninitiated and it would be ideal for serious investors willing to commit time and take those risks. As David madden says through one of his characters ‘a person who risks nothing, does nothing and has nothing’.

Meanwhile my exotic PMS managed by a well known fund manager has severely underperformed my own Nfty ETF investments by a huge margin.

Our cumulative learning over time proves high sounding, exotic investments from elite fund managers does not better the returns from effortless investments with low charges.

http://blog.learninvest.in/

Mutual Fund with a Twist

This week I had the privileged opportunity to meet Professor Narasimhan who teaches corporate finance at IIM Bangalore. No matter how much you know, one can expect something new in such interviews. Prof overwhelmed us with his very simple yet powerful insights into how to invest in equity and markets in general. He was addressing group of final year MBA students who sought it as a parting gift. He explained Relative strength analysis in detail and suggested that to people who would have a lot of time. And for those who were entering the busy corporate world he gave away another easy program that I guess makes a lot of sense to many of us who are working on urgent but less important issues.

The program was to invest in mutual fund investment with a twist. He suggests that one should not invest in stocks directly unless he is prepared to spend several hours in a week preparing for it. For the rest he suggests investing in a systematic investing plan in a debt fund initially. He explains that we then look up for the 100 day ‘daily moving average (DMA)’ of the index as a whole. This can be looked up under ‘technical analysis section’ after getting stock quote price of ‘S&P CNX NIFTY’ in finance site like yahoo. The DMA is an average price graph that removes the noise in the market; it’s a smooth line that cuts a second choppy price line. Here is the method he recommends. When the price curve cuts the 100 DMA curve from below (bottom to top), move the entire holding from the debt fund to the top diversified equity fund. In the reverse when the price line cuts the 100 DMA from the top, switch the holding from equity fund back to the debt fund. This, he reasons, as the safest strategy that ensures two things. One: Yor wealth will never get eroded due to a huge market fall and second: ensures you will never miss out a huge upward movement. This is like ensuring you exit before the market crashes and enter before the market goes up. This system allows you to sell at higher price and buy at lower rates in general. If you have a look at the 100 DMA for a period of 5 year, you would be able to relate.

Now let’s talk of the flip sides. You may do multiple transactions in a short time if market is volatile and incur trading cost. But if you see the last average of last 5 years, you would have done about 5 transactions a year, a small cost for the advantage it offers. You will never be caught napping if there is a sharp correction or again you would be invested before the market moves north. The second flip side is that you will not be able to enter at the lowest level or sell at the absolute peak. The third factor as you will make out from the graph is that you may buy at higher rate causing regret or you would have sold too soon loosing potential gains. Blame this on behavioral problem and to be successful he advises “never develop regret factor in investing”. The lighter way of saying that is leave some money on the table for others to take. He assures this method will allow you to make significantly higher returns than investing directly or through a mutual fund.

He reasons that you will be able to beat the market because you are constantly selling and as per him selling is how money is made as most us are very bad sellers either selling at lows or not selling at all. Selling at right times will help us out-do the market in performance. The other behavioral aspect he asks to overcome is the anxiety of the future not of the financial markets in particular but of the personal life in general. He exhorts students to be relaxed and not chase money rather have a balanced approach as nobody who ever had lot of money was always happy. In As Kartik Sharma said ‘There is a middle path, a happier path. Where we do not have to give away all those things that make us human, just to get an excess of one thing – money’.

David Geffen knew it when he said “Anybody who thinks money will make you happy, hasn't got money.”

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Desire, Deserve, Dream, Destiny

I was speaking to an investor who described investing success as a meeting point of skill or competence with opportunity. As with everything in life success is the confluence / conference of a destined event upon a person who has the wisdom to make good of it. Imagine what would have happened if Sachin was born on a non cricket playing country like France. Or what could have happened to the talented Baichung Bhutia if he was born in Europe. He exemplifies great skill but certainly not the right place. So also in business and investing the talented one should have recognized a great opportunity or a destiny event should have smiled on him. A great investment opportunity that appeals to us as an investor would click when we have the sets of competence to recognize and exploit it.

Sunder "Ashok" Genomal of Page industry is bestowed with ability to nurture brands that entice the aspirers and affluent. He can keep a brand young and new. He struck the right opportunity when he signed as the licensee for jockey in India. Page has been going at a scorching pace which registered net profit growth of 54% in FY12. His family was associated with page in other parts of the world and he was introduced to the opportunity. Dr Desh Bandhu Gupta had great execution skills. He struck the right opportunity to make most affordable medicines and targeted for the most prevailing diseases such as tuberculosis. His company Lupin has delivered a CAGR of 31% in Net Profits for the last 7 years. Of course they were lucky as they worked hard for their Nobel cause.

Ross Brawn was a super mechanic with Ferrari working in R&D department and an aerodynamicist. He was their F1 race strategist. When the loss making Honda was withdrawing its F1 team in 2008, Brawn bought them out and turned it around. Brawn GP won the 2009 Formula One Championships. Brawn then sold the team to by Mercedes-Benz in November 2009 raking in profits. He worked his circle of competence to his advantage by being aware and grabbing an opportunity.

As investors too, opportunities should complement our skills. A successful medical practitioner trying his hands in stock investing, or an illustrious techie farming organic vegetables is fraught with danger. A retail investor who has limited understanding of investing should not complain of losing money because his skills are misplaced. Prof Narasimhan who teaches corporate finance at IIM Bangalore says reading financial statements is very complex and there are too many nuances for a small investor to comprehend. A small investor, he reckons, should be investing in Benchmark ETF, Mutual fund or privately managed funds and he will stand a reasonable chance of making money. For those investors who are keen to do it themselves, he suggests a 3 step check to weed out the bad as he has no skill to understand financials himself. Look at the dividend track record, its place in the industry and governance. He insists that the company should have been paying dividends for past 10 years and should be the within 3rd largest in its business as size matters when other parameters of financial understanding is limited. Good governance is the only key measure he possesses to trust the management that runs it. Good governance can be screened by looking at the institutional holding in such stocks.

Lastly to succeed one must intensely desire, deserve, dream and be destined. We see that in entrepreneurs and it explains why companies like Nirma, Biyani, Vedanta or Mittal have grown at scorching pace while those like HUL run by Ivy League managers have seen tepid growth. Relatively their market caps have not greatly expanded in the last decade; obviously their managers have not missed paying their EMI or had to move their children out of international school. As opposed the unquenched fire in entrepreneurs were driven by the 4Ds. As investors we must put our money where our mouth is.

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Cash Excesses

Apple recently announced huge share buyback program picking up 10 Billion of its stock. Apple earned piles of profit and this could be the right thing to do for a company which is very cash rich, hugely profitable and does not know what else to do with cash stacks. It is certainly better than many cash surplus companies that diversify from the core business into new ones only to erode shareholder value. We can recall many such instances closer home of very profitable businesses who failed to manage such huge piles of cash. They went on to diversify only loosing share holder’s wealth. When a company buys back its own shares from market with the surplus profits, it actually reduces the equity shares outstanding in the market. The earnings in subsequent years can be shared amongst lesser equity holders and boost earnings per share (EPS). When the EPS goes up, at similar valuations (P/E ratio), the share price goes up. It also puts more money in the hands of lesser equity holders by way of dividends. This is the best thing to do for a profitable company rather than haphazard diversification.

The previously very profitable Future group learnt it the hard way, when it’s reckless and loosely made diversification (to deploy its huge profits) backfired. They then let go of the profitable Pantaloon to retire some of the debt. Huge profits and troves of cash is a happy problem to have but history has shown that not much management is successful in managing this situation well.

The combination of Overconfidence in our capability, competence and feeling that 'I cannot go wrong this time’ coupled with disposable surplus cash is a deadly & potent concoction for disaster. This tendency is seen in the companies that we invest too that diversify recklessly especially those that had a history of success and healthy cash flows. These growth pangs are a happy problem that many companies dabble with limited success and damage shareholders wealth.

In my previous blog I wrote about how future group diversified into financial services and lost their sheen. The stock price of FCH at time of listing in Feb 2008 was around Rs 765 and now is Rs 150. Videocon, a successful consumer Electronics Company entered telecom and made a hash of it. The very successful Marico which makes parachute brand oil had lost money diversifying into Kaya skin clinic. Inebriated with success, the UB group diluted its potency by flying into aviation business with Kingfisher. Similar examples dot the corporate landscape. The very successful telecom service provider Bharti made so much cash they wondered how to spend it only to diversify into insurance and Mutual fund. 5 years later, they had less than 1% of the life insurance premium underwritten by the industry as a whole. All these companies had diminished the valuations of their core business. Unitech's diversification into telecom or RIL’s foray into retail has only caused severe loss to share holders. Reliance is faced with the biggest challenge of having to manage an ever growing cash pile. It has been unable to acquire or diversify in a manner meaningful to the shareholder displayed by stagnant earnings.

Managements have the responsibility of judiciously investing shareholder’s money, deploying it in a manner that earns returns for its shareholders that trusts them. How much such management we can trust to invest our money prudently and how much premium are we willing to pay to have such management will decide the returns we make. As we see having too much cash and being profitable is a challenge.

An efficient company makes more money than they spend. Such companies re-invest excess cash generated into their business, which is already generating a lot of cash and produce even more profits. This cycle may not continue endlessly. There could be circumstances when the company is unable to put the cash to good use. In such times, it would be ideal for them to pay it back to share holders as dividends or buy back their own shares if market conditions are favorable. Apple has stayed focused on its core business deciding to reward shareholders by way of share buyback that will result in higher Earnings per Share. There is a caveat though: a few dubious managements use buyback program to increase the wealth of their top executives by buying their stakes at an unrealistic and high price.

The European concerns have been bothering the world economy. The story can be different each time but the cycles of economy and business continue to turn. A deep crisis of confidence is an opportunity. As they say, never let a good crisis go waste.

Illusion of Analysis

A leading publication recently carried an article on Equity- returns versus fixed deposits that stirred a hornet’s nest. I got many calls asking if this was true, why I would recommend investing in equity. The story went like this: the author carried out a research of the last 20 years returns that Sensex had delivered. He concluded that the Sensex which was quoting 4285 on April 1992 is on 17,404 at April 2012. He calculated thereby that the Sensex had delivered an annualized return of a paltry 7.26% against an FD of 10.28%. Mathematically (=((17,404/4,285)^(1/20 years))-1), this made sense. However neither the choice of specific period nor the silence around elaboration really helped investors. I decided to do more research on this to extract any learning. I rewound by 3 months to 02, January 1992, the Sensex was then quoting at 1965, and recalculated the returns for the same period ending April 2012. The annualized return suddenly shot up to 11.52%. To further illustrate my point, if you consider another specific period between Jan 1992 and when the market peaked in Dec 2010, the annualized return works to 14%, although it becomes very biased. But that’s exactly the problem of statistics.

The famous anecdote of Malcolm Forbes illustrates this story. Forbes once drifted away during his -famous hot-air balloon pursuits and landed in a corn field far away from civilization. He fortunately found a passerby and asked him where he was. Pat came the reply, “Sir, you are inside a basket in a field of corn. “ To this, Forbes asked him if he was a statistician, and the person was astonished. “How did you know, sir?” Forbes said “Your information is concise, precise and absolutely useless.” Forbes’s reply cautions every investor not to get carried away completely by data slice and dice.

During my research on the same data-set, I calculated 10 yearly-returns for every month-ending between 2002 and 2012 , starting from 1992. I had a sample size of 136 ten yearly annualized returns. The 10 year returns varied from -2% to +19.47% , which means you could have waited for 10 years and made a negative return or a +19% depending on the period of 10 years you chose. A similar analysis of 5-year hold period showed an annualized return between -5% & +46%. Frankly, this data- set means little to investors as long as we can broadly take some lessons. You need to constantly keep tab of your investments; a half-yearly check on the stocks or mutual funds are absolutely necessary. The 7.26% paltry return the author referred to was from a sensex level of 4285 in April 1992, after the markets ran up from a sensex level of 1965 in January 1992, doubling in those 3 months with a peak valuation of about 55 times. It therefore goes that we always step aside or partially liquidate after the markets have run up to crazy valuations. It is difficult to value an asset but not that difficult to ascertain overvaluation or undervaluation of stocks. If you are in SIP, it means you can do a systematic transfer into a debt- fund and re-enter at favorable valuations. For instance, in the above example, the markets were available at fair valuations of 15 (P/E ratio) by December 1995. Normally, such rapid movements of stock- markets are followed by periods of stagnation or slow growth. We discussed this in details in a previous blog. We must fend ourselves from the belief it is possible to make easy money without commensurate efforts.

To understand these risks better, we need to have a handle on valuations. It is very difficult to price an asset precisely. But we can identify if the asset is overvalued or undervalued with relative ease. The P/E is one way of doing it, but that alone would lead to pitfalls. . In Japan, a few decades ago, investors were paying 40 times, hoping for great future earnings. However in the years that ensued, the confidence was rattled and investors were ready to pay less than 20 times. So while businesses continued to grow, the investors were willing to pay much less, leading to very low or negative returns for a period of 20 years. So we had a situation where businesses were doing not- so- bad, but the returns from equity stagnated for many, many years. The question of what price to pay is akin to asking how much are you willing to pay for the Taj Mahal? By and large we can expect that stocks with low P/E will out do those with higher multiples, other fundamentals remaining the same. Hence Great companies need not really make great investments.

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Forbidden Fruits

A few events in the recent past triggered my thought on the forbidden fruits for small investors like many of us. Anil Ambani sold his stakes in NICE (Nandi Infrastructure Corridor) for Rs 300 crore last month, a stake he bought for Rs 44 crore 7 years ago, compounding a return of 32% per year. In the recently listed MCX IPO, the issue which was allotted at Rs 1032, listed on at Rs 1387. The listing gain of 34% is hardly any good news as only a few lucky small investors managed an allotment for the issue was oversubscribed 24 times. Those retail investors who applied 192 shares (maximum quantity under retail category) would have got 8shares. Then who actually made money? The early investors which included Indian Banks and a handful of foreign investors made a compounding return of about 40% pa over previous 4 years. They went laughing with all the money at the cost of retail investors who bought their shares in a hurry at listing. Now you and I cannot do this. This is an exclusive arena for a handful of financial institutions who have managed to keep this treasure trove to themselves. There is no easy way for an average investor with Rs 1 lakh to be an early investor in such issues. Why should it be out of bounds? What can’t sebi come up with guidelines that mandate companies to allow retail investors to be part of an early business story? There are some funds which have tried but most of them have only passed on risky assets as we bear the downside.

Bhatkal Raja however does not get agitated by such unfair advantages handed out. He is a seasoned investor who has learnt not to draw comparisons. He believes 30% return is an exception and any investor who tries to compare such windfall is doomed to be sorry. Raja is right, as in comparison lies the root of all grief. I met Raja during one of my interviews and was impressed by his approach that he has steadfastly followed ever since he started working.

Never invest in a lump sum. Always invest at all times. This is a simple yet highly effective strategy. His investments have compounded at return of 15% pa over last 10 years. He has never missed out a single month of investing which has helped him average his purchase cost. He invests a fixed sum every month for retirement over next 25 years and increases the allocation every year to adjust for inflation. Never invest a lump sum giving in to the arousal of high returns when the markets are on a roll. Nor be disinterested but continue monthly investing when markets get into passive phase.

In my recent meeting with a stock broker I realized how many of them have packed up. The industry is finding it very difficult to stand on its feet due to very low investing & trading interest and eroding commissions. Most investors today discuss about real estate and this has emerged as a proxy of how well people are doing financially. This is an indication that today is a stock picker’s market and evident from the world of stocks available at less than book value.

As long you have an objective and stick to it without faltering or deviating, you are likely to be successful. Many of us are like children in toy shop picking up every toy only to trash it for a better one sighted. Finally we may emerge from the toy shop with no toy in hand unable to make choices or disillusioned. As the French proverb goes, he that seeks trouble never misses.

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What do you price an overpriced

This story is about a company that is celebrating 100 years of business in India and whose EPS has crossed just over 100. Nestle started its India operations in 1912 by importing and trading milk products and chocolates. The net profits of the company compounded at 17.5% every year over the previous years. The stock price catapulted from Rs 285 in the year 2000 to Rs 4500 in 2012 (not withstanding the 160% average 18 dividend payments) with laser focus to deliver Strong operating cash flows. Nestle’s net profit grew at a CAGR of 21% per year from Rs 118 crore in 2000 to Rs 961 crores in FY 2011. The eps also grew from Rs 12.30 on year 2000 to Rs 100 in 2011, again a CAGR 21% (per year). This is too good to be true. It’s heartbreaking to miss being part such a company that is a true wealth generator through innovation, unparalleled distribution and invaluable brands. How many companies can we recall that have survived for 100 years? Hardly any. Nestlé’s recall has been painstakingly built over 100 years. This is a feat that is not easily replicable by simply making large investments. Hence one can safely expect that this growth of Nestle will far continue into the future on the back of the strength of its brands and popularity of its products.

But look beyond and we will learn some lessons. When nestle has grown at a compounding rate of 21 % over the past 12 years and if it is guaranteed to continue its growth engine for many more years into the future, investors will quite naturally overpay for the stock and make it expensive. The markets will overprice such businesses having demand and with a moat. Nestle's intrinsic value is around Rs 25,000 crore when I last calculated while it is quoting now at Rs 43,000 Crore making it highly overpriced. When such growth engines like Nestle are overpriced, how can future returns be possible? The returns on our investments are proportional to the price we pay to buy them. We can't over pay a growth story and expect to make great returns. In the recently held IPL Auctions, Ravindra Jadeja was bought by CSK for Rs 9.72 crores plus a secret tie breaker amount. Would CSK have been ready to bid 10 times more than that as tie breaker amount? Would it have made business sense? Jadeja has a finite value to the CSK’s IPL business and would be bought at a commensurate value that makes business sense. If the price paid for an investment is high, it would diminish the returns on the investment. Investors must factor this Margin of safety which tells us how cheap is the going rate over the actual valuations. A 25% margin of safety ensures we never over pay.

Like many paradox in life, we are very optimistic about a stock generally when it is overpriced and are pessimistic when they are undervalued. The capital goods, infrastructure and power stocks trade at very low p/e multiples today because the market considers future prospects of this industry very bleak. Just yesterday they were poster boys of the stock markets.

No one can make an accurate forecast of the future of the market in general or an industry or stock in particular. Future as ever shall continue to surprise the one who is absolutely sure about it. As an investment expert said “The worst the financial market’s future look, the better they will turn out to be". Keep investing in little, over time and stay invested.

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Iowa Gambling Task

Why do people invest differently? Why do some always lose money in markets and why is it some people refuse to lose money by not investing or postponing their decisions? Yet there are people, who are remotely connected to markets, inherit huge holdings and never do anything about it but they grow their wealth many times? Yet there are people who invest to lose money and never return?

It’s about how the brain is made and how we make different decisions to same situations. Recently I tried Iowa Gambling Task online to better understand my investing behavior. It tells you if are a carefree risk taker, or fear losing money in market, or are you the one who will take money away when the market tanks. Such investing behavior potentially inhibits your success. The task also reveals if your brain responds to low risk bets and limits downside, such behavior helps build reasonable portfolio returns. The wiring of your brain will manifest in investing decisions. If you are low on wiring as you can make out in the Iowa Gambling Task, it would be better for you leave your wealth management to professionals or invest through a market or index fund.

The investing part of the brain can't at times handle prolonged period of low return. We either kick ourselves for a poor decision or exit early causing irreparable investing damage. I had the opportunity to understand this recently when I met up with a well known Fund manager. He was legendary at one time for his multi-bagger picks like Sintex and Pantaloon. His funds were number 1 for years in a row. A bull by nature, he can't retain a negative opinion for long. He remembered investing in Pantaloon in the year 2002 and then the stock never moved for almost 3 years since. During that period it was stagnant hovering around Rs 10 per stock. But by 2005 or so the stock went up to Rs 300 per share. Now in retrospect would you say it was the right pick or not? Most funds could not ride the wave as they exited the stock owing to long stagnation at early levels. In the fund industry, if the fund manager does not deliver returns better than the index and peer funds for 2 quarters in a row, he will be axed. So it becomes difficult for him to stick to stocks like Pantaloon for 3 years without his investments delivering. As an individual investor, we are under no such pressure and hence can better an average fund-manager.

However as small investors with limited power to influence businesses, one key factor in investing is to look for companies with strong management you trust. As warren buffet said "I'm hunting for companies that have some kind of a sustainable competitive advantage, that have the kind of management I trust and that I can buy at a price that makes sense". The management who are transparent, have rewarded shareholders over periods of time, are trust worthy and those who know their businesses very well. They merit attention especially when they have done some mistakes or are going through unfavorable markets conditions as that is when you get the businesses at price that makes sense. I looked at 2 companies that are in such situations. Pantaloon moved on to reach dizzying height of 800 at the peak of the retail revolution and euphoria in late 2007 and early 2008. The company made so much profits that they wondered what to do with so all the money. Pantaloon attempted at multiple diversification which weekend the business and towards Jan 2012 hit a low of 125 per share. Pantaloon is run by management who know their business very well and they quickly got out of all thinly diversified businesses and are back to focus on core area of retailing. Recently when the FDI in retail bill was getting passed the stock shot up to 240 in one week and later lost steam as the FDI bill was shelved. The stock is back to 150 levels and is a potent stock run by well qualified management and when FDI in retail becomes a reality at some time, will benefit from it coupled with prospects of earnings & business growth. There are other great businesses run by management who know their business very well but have been battered by the markets due to short-term challenges that will pass by. Varadaman Textiles which was around 6000 crore in market cap is now 1200 crore, and is available at half its book value. Their fundamentals have not changed, nor have their management.

The secret of financial success is within us. If we invest with Patience and confidence coming from knowledge, we can take advantage of many situations around us and by refusing to let optimism or pessimism dictate our destiny. As Jason Zweig said, how our investments behave is much less important than how we behave.

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Cash for Clunkers

Cash for Clunkers is a program that allows one to trade in an old gas guzzler cars in exchange for a new fuel efficient car. Around the time we stepped into the New Year, I decided to introspect into my portfolio and get rid of the gas guzzlers and dud stocks. Those were the stocks that existed because I bought them for no reason. Often times we pick up names of companies that we want to invest in, based on corridor discussions. It sounds very exciting for the first time, the story of how well the company is diversifying or the scorching pace of growth etc. Anticipation of future gains makes us feel very good and proud. This lovely feeling subconsciously motivates us to reach the phone and place a buy order for this great new stock. We give in to this feeling every time we hear about a new stock or a company and we end up with a portfolio of stocks we should not have bought in the first place. This portfolio, I would tend to call a Clunker. The biggest challenge is in getting rid of a clunker portfolio. Selling looser is no easy as it makes you feel wrong. Hence you hold on to it for eternity as you see the value depreciate by, with hopes that one day market will prove you right. This is one big challenge in making money in stock markets. You want to look good in-front of yourself and would never admit to a mistake by selling the looser. Research has proven that we are twice more likely to avoid losses than favour potential gains. To sell a looser is registering a loss and hence we hide behind the hopes of a turnaround. A stock does not become a looser just because it has fallen in value. If the intrinsic value of the business is intact and the stock prices could have fallen for other reasons, it could be time to buy more. Hence I don't believe much in stop loss.

So I went ahead and identified 5 stocks in my clunker portfolio and after days of research I decided that there was not enough reason to hold them. By selling them I not only got out of a losing proposition, I generated cash that I could now put to better use. Given that the markets have corrected quite a bit, I had identified a few stocks with juicy valuations to savour. Selling winners too soon is as responsible as holding on to looser too long, to diminish investing returns. It helps to stick to a simple rule of why you should not buy ? This primarily takes the spotlight away and you tend to ease a bit from illogical decisions. You get to avoid the looser stocks in the first place.

The markets have corrected about 25% in the last one year and while we fish in troubled water for good stocks, my friend reminded me of a great sitting option for people with home loans. Look no further in the stock markets for exciting stocks. The interest rates have peaked and if you are one of those with a home loan, paying 12 or 13% interest, there are no better times to part-pay the outstanding. Most banks have today waived off part-payment charges as was mandated by RBI. You are making your money work for you the best possible way and earning a guaranteed 13% neat return. As they say the best things about life are very simple.

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Kolaveri & Investing

Kolaveri di, the Tamil song was released digitally on November 16 and became a raging success online with more than 10 million downloads. The country danced to its tunes as the craze spread like wild fire. The song became an outstanding hit for its simplicity, rustic, slang power & contemporary style.

Javed Akhtar calls it an insult to sensibilities and fundamentally weak with substandard singing and ordinary tunes. Yet its popularity spread at hysterical proportions as with rock bands, face book and other fads. Its popularity spread as people do not lose out on what their friends and acquaintances might have gained. So if Kolavari gets a few million hits, be sure that the same hysteria will propel it even greater fame. The fad soon fizzles out when the newness and mystic around it is lost with time.

This Kolaveri phenomenon shows up in the investing world in the form of IPO and hot tips. Word of mouth is a powerful influence. That’s when we see an IPO is subscribed 80 times and when the listing happens, the newness & mystic fades. Soon reality bites as we seek adventure in newer ideas and move on. The scrip then loses its initial high on listing and like Kolaveri, the zeal and enthusiasm dies out. Only that with stocks, it leaves your purse lighter. This has been a great example and should serve like a speed break when we spot on ‘marvellous’ ideas and ‘hot tips’ from friends or brokers.

Recent IPOs of Reliance Power or Punjab and Sind Bank or the deceiving elements of sectoral funds prove this. The reliance IPO was oversubscribed by 77 times at an issue price of Rs 269 (after adjusting the bonus of 5:3) in Feb 2008. There was a mad hysteria around private sector power producers and their great prospects in a power starved country. There was a huge build up and entire country expected to make a fortune by subscribing to it. Virality was induced by word of mouth as people rushed not wanting to lose out what they expected others to gain. This explains why the IPO was subscribed by 77 times. It is trading currently at 85 losing all the money for investors. There was also the case of IPO of Punjab and Sind bank which subscribed 80 times driven by the theme -last PSU Bank to go public. Again the grand expectations built on a simple and easy to understand logic actually made one feel like having an egg on the face. It was issued at about Rs 120 and is now quoting at 68. These are a few examples of how mass hysteria can come in way of logical investment reasoning. During the period preceding dot com bust, the IT sector Funds mobilized huge amounts of deposits riding on mass hysteria that IT was the solution to world hunger. In the aftermath of 2002 meltdown, almost all sectoral funds lost money for investors and closed.

In a Diaspora of people with shared beliefs (of say 'stocks hold the future' ), certain ideas (Power deficit country, or last PSU Bank to list) can cause emotional excesses or create anxieties. They start acting on these (such as subscribing to an IPO or buying into sectoral funds with no research or reason) and soon the magnitude (interest in an asset class measured by how may subscribe) gets out of control. This explains why a dud IPO or a dud fund receives overwhelming interest to a theme and how they assume geometric proportion like getting oversubscribed by 80 times. As with any Fad, investors in such hot tips or IPOs and theme funds, lose out.

No economy in the world has ever grown at a scorching pace continuously. Studying economy moderates our view, that a growth of 4% after inflation is only the realistic estimates in long term. Certain markets or stocks can return higher than the average economy, but will fall back soon to a mean. Hence if there is great run up then it is typically followed by periods of reduced growth or slowdown. Economists call this regression. Investing in a stock that has given scorching gains is fraught with risks as there is no question whether you would lose money, it is only when. As a corollary, great companies that have lagged the markets severely can be expected to gain to at-least to an average mean. I discussed this in the previous post.

It is hard to predict which stock or song will be the next Kolavari as in this case even super star Rajini admits he couldn't predict Kolaveri Di's success. Not to mention Team Kolaveri still wonders why it became such a rage.

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